In a recent interview, SEC whistleblower Gary Aguirre offered his insights into the regulatory failings that allowed the Bernie Madoff scheme to reach such enormous proportions for so long.

Aguirre places particular blame upon the “revolving door” culture that hangs over the SEC’s workforce, with its attendant promise of a lucrative move to the private sector in store for those whose approach to regulation is deemed acceptable to the regulated.

The system maintains itself, because those that stay know their turn will come if they play the game. They see a director or associate director move onto a $2 million job with a Wall Street law firm. Then, the departed employee calls back to his former colleagues and says, “you know I really don’t think there is much of a case against so-and-so, I’d like for you to take a look at it.” And the case goes away; the system goes on in perpetuity … [There’s a] culture of ‘don’t rock the boat,’ the industry does not want ‘boy scouts,’ and if you can be effective with the SEC through your contacts, that is a very valuable asset you can bring to the table.

To summarize, Gary Aguirre says that a large part of the SEC’s widely-acknowledged (though not as yet fully comprehended) dysfunction results from the self-reinforcing cycle of:

High level SEC staffers accepting positions with powerful institutional market participants, in order that they might…

Pressure their former associates to take regulatory action beneficial to their employers, and in the process…

Impressing upon former associates the value of regulating selectively – as the former staffer had done – in order to ensure their own eventual move to the private sector.

This revolving door dynamic is at the heart of the high degree of “regulatory capture” observed at the SEC and a central focus of this blog.

But enough of the theory of the SEC’s revolving door…let’s look at it in practice (as Mark Mitchell did in a superb item last month) through the example of Richard Sauer, former assistant director of the SEC’s Division of Enforcement.

First, a little background.

In June of 2003, after 13 years with the Commission – including seven as assistant director – Richard Sauer left the SEC for the law firm of Vinson & Elkins. There, among his clients, Sauer counted Rocker Partners hedge fund.

On October 6, 2006, the New York Times published Bring on the Bears, a rather lengthy opinion-editorial authored by Sauer, which argues, on the surface, that short sellers are as vital to healthy markets as predators are to healthy ecosystems.

Fair enough.

But set in the shadow of that well-worn market truism are some disconcerting clues as to Sauer’s mindset, both present and past.

For one, Sauer is dismissive of the uptick rule (a provision created to prevent bear raids intended to drive a company’s stock down) as an unfair vestige of a by-gone era, calling for its elimination.

For another, Sauer reveals that while at the SEC, he initiated many investigations into public companies based on the tips from short sellers betting on a drop in those companies’ stock prices. Indeed, he says short sellers were his only source for these kinds of investigations.

And for yet another, Sauer defends the relationship short-biased hedge funds have with journalists such as Herb Greenberg, Roddy Boyd, Carol Remond and Bethany McLean, while calling on the SEC to initiate enforcement actions against companies that “attribute their woes to conspiracies by short sellers,” and “retaliate against critics through defamation campaigns and manipulative short squeezes.”

As unsound as his logic is, on one point we can be certain: Sauer is at least telling the truth. A former co-worker confirms that while he and Sauer worked together at the SEC, Sauer had been involved, at least tangentially, in most of the investigations instigated by short-selling hedge fund Rocker Partners.

But the most telling sentence in Sauer’s op-ed piece is the one he didn’t even write, but which appears a the end, as an editor’s note. It reads:

Richard Sauer, a former administrator in the Securities and Exchange Commission’s enforcement division, joined the management at a short-biased hedge fund this week.

Of course, that short-biased hedge fund turned out to be Rocker Partners (which had recently changed its name to Copper River Partners).

In December of 2006 Institutional Investor Magazine published a small story on Sauer’s new gig, noting that “[hedge] funds regularly brought [Sauer] complaints of possible wrongdoing at companies they were betting against.”

In point of fact, thanks to emails produced through discovery in the Fairfax Financial (NYSE:FFH) vs. SAC Capital, et al, lawsuit, we know that there was nothing at all remaining to be seen, for by mid-November of 2006, Sauer had already emailed keyesr@sec.gov (someone he apparently knew well enough to address only as “Rob”), pointing him to one of the anti-Fairfax sites set up by Spyro Contogouris, and attempting to spin Contogouris’ then-recent arrest on embezzlement charges as a Fairfax-motivated act of retribution.

In light of what we’ve just learned, let’s revisit Gary Aguirre’s theory of regulatory capture at the SEC:

Former Associate Director of Enforcement Richard Sauer accepts a position with Copper River Partners, a short-biased hedge fund known to be heavily shorting Fairfax Financial.

Sauer pressures former SEC colleague Robert Keyes to take regulatory action likely to negatively impact the share price of Fairfax.

Keyes is impressed by the need to regulate selectively – as Sauer had most likely done while at the SEC – in order to ensure his own eventual move to the private sector.

And the cycle continues.

Of Aguirre’s three requirements, we can state with certainty that in the case of Richard Sauer, the first two are satisfied. It is my opinion that the third requirement has been, as well.

What all this means is not that Richard Sauer is a bad person, for I don’t know a thing about his character. What I do know is that he has spent most of his professional career enabling bad people, first from within a fatally flawed regulatory agency, and later from without.

Mr. Sauer, if you’re reading this, given your recent unemployment following Copper River’s collapse, I sincerely hope you’ll hold out for a job that breaks the cycle of regulatory capture and actually makes the world a better place in the process.

16 Responses to “A hedge fund suite for Richard Sauer”

Saying that we need predators in the market killing companies is equivalent to saying that we need murderers roaming the street to keep the population healthy.

One of the primary themes of classical tradition was that man could use rationality to overcome the base state of nature.

That tradition works. It brings on prosperity.

Mankind is a rational creature. We can improve our lot through reason and deliberation. Short selling appears to be undermining the ability of investors to engage in the rational process of assessing investment options. With modern communication technologies, the market is so efficient that we no longer need artificial regulatory measures like short selling.

Just as we don’t need rogues roaming the streets randomly killing people, we don’t need an elite class of insiders in brokerage firms randomly destroying companies.

Human rationality overcomes the need for predators.

In the last several years, there has been a predator class randomly killing large numbers of people in Iraq. I see absolutely no sign that the average Iraqi is better off with the killings. They actually look quite miserable and unhappy about all the killing.

Anyway, the current rot in Wall Street is more like a plague than a sleek predator. Sauer’s argument is akin to saying that the market needs to be covered with a festering pustulation to be healthy.

Mankind is a rational creature. We thrive by using reason to overcome the plight of disease and predators. That’s why there’s billions of us. Sauer is simply repeating a failed elitist ideology that causes widespread hardship and misery.

The SEC’s own annual report proves that they lied when they said SHO works.

Failures to Deliver jumped 69.5% from 2005 to 2006, then another 34.6% from 2006 to 2007 with 2007 fails to deliver at least $60.1 billion. I believe this is based on NYSE fails (FOCUS reports), which excludes OTC and Pink Sheet stocks and any trading hidden outside of America or netted x-clearing between partners in crime, so this is a really “lower limit” on the real crime.

Check the comment section of the last blog post for my other posts of other links from the SEC’s own site, but the main theme is that the predators are there to eat the retail investor and keep the herd of stupid retailers strong by screwing the dumbest ones.

“But it seems to me that the optimal thing for the market maker to do might be instead of holding a large inventory when somebody comes with a buy to sell to them, you know, if somebody comes to the buy, just short it, just borrow it. It lowers your inventory cost.”

(SEC study)
“First of all, it was rather surprising to see how large a percentage of sell orders are short sell orders. As you can see there’s roughly 23 percent of all sell orders are short sell orders, a surprisingly large percentage.”

– there are usually more buys than sells when you look at market depth. Unless the price rises unnaturally, the only way to match it is to increase ask depth by 30% (naked shorting)

– allowing prices to rise by reducing shorting will lower average investment returns

– a higher price encourages companies to raise money and then waste it

– “If you look at the history of enforcement actions at the SEC, the number of actions to deal with pump and dumps vastly, vastly exceeds the number associated with bear raids. Bear raids are very uncommon.”

– shorting protects investors from paying too much “How many traders complained about being sold very high priced stocks in the late 1990s, and then after that lost a lot of money? I think huge numbers of small investors felt in retrospect like they got ripped off.”

– “So I agree with Larry that the short sellers are the big ally of the SEC in its efforts to protect small investors from schemes that would, essentially, be manipulative.”

– “the locate rule is an effort to throw a little bit of sand into the gears that would otherwise smoothly allow a market for borrowing and lending securities to operate.”

– And one of the proposals that I understand is up for discussion is whether buy-ins should be more strictly enforced to eliminate short positions on which traders have failed.
If you more aggressively force traders to liquidate their short positions, you make it easier for someone to corner the market and squeeze the shorts in the stock market. This would have the bad effect of making the schemes that Larry talked about, the pump and dump schemes, easier to execute and would, I think, therefore, be kind of a bad idea. So rather than have a forced buy-in for short positions that have been failed on for a long period of time I would recommend as an alternative just a series of escalating modest penalties”

– the cost of naked shorting falls to zero when interest rates are at zero as the only cost is borrowing to cover the margin on the fail

– “Short sellers are very important parts of our capital markets. Short sellers get pessimistic information into prices. We don’t want just the optimists to have a vote. We want to have pessimists also to express their view.”

– “I would characterize short sellers as an oppressed minority.”

– “why we were worried about downward price manipulation but were not worried about upward price manipulation. So it seems an odd, sort of, asymmetrical rule.”

– “I think banning trade, which is, essentially, what the uptick rule does, is rarely a good idea”

– “I was getting progressively more sad and more sad going through this discussion here. And I kept thinking poor uptick rule. I mean, it has been with us for 70 years now. Anybody to stand up in defense of the uptick rule? Well, it’s not going to be me. Of course, the other challenge I have I’m the last here, and so how can I make it different and interesting.”

– “short sellers are already handicapped, a lot of restrictions.”

– the retail investor “facing the lions and debating whether the ethics of eating someone that’s there to be eaten.”

– “the smallest stocks right now aren’t subject to the tick test, and you don’t see a lot of people clamoring for it. Of course, those are the ones that are most subject to the pump and dump.”

– the commissioners get spam emails telling them to buy stock, but they can’t go after the spammers at they have a right to express their opinion from eastern Europe. Naked shorting needs to be allowed to protect unsophisticated investors from paying too much for these scams.

– retail investors are often confused

– “But if they were going to be threatened with a buy-in on their 100 percent of the flow, that would eliminate their ability to protect the small investors from exorbitant prices.”

– “What I’m worried about is, you know, you publish stock ABC. It has a lot of short interest, and the CEO of stock ABC, who is a evil pump and dump guy, sees that and uses that information to somehow manipulate the securities lending market.”

– “Ken Lay’s defense was that Enron was a victim of a bear raid. I didn’t buy it. The jury didn’t buy it. I don’t know if anybody bought it. But the bear raid is the story that a CEO tells when the market is voting against him.”

– “I think bear raids probably occur hardly ever”

– “who is going to complain about being able to buy depressed stocks at really cheap prices and earning a great return on that?”

– “So after September 11th there was a massive manhunt for the alleged — Osama bin Laden was allegedly short selling airline stocks on September 10th. So there was quite a search for nefarious short sellers after that,”

– “The example of Osama bin Laden is insider trading, not a bear raid. Let’s make sure we have the distinction right.”

– “Maybe we should have transparency where everybody’s Social Security number is posted on the internet. That would be a form of transparency most of us probably wouldn’t like.”

If I remember correctly it wasn’t Ken Lay who said the problem with enron was a bear raid but Schilling who said what we had was a run on the bank. Here’s the bottom line from one who has restructured a few things in my life. Determining the problem is not the hard part. And knowing what to do is not the hard part. The hard part is making it happen. It was very obvious to me long ago that the system was broken going back to the days of the early 80’s again in 1987 and perods after such. UNTIL we get some very integrous individuals to do THEIR jobs, this is going to be a game of hide and seek to give the appearance of a fix whilst few will never learn the true culprets in this game of cause and effect. Those who defend are either complicit or ill informed. A bear stearns or an Enron or a Worldcom just don’t collapse. A Leh doesn’t. Nor does a Wang labs. I inform all I can but in the end ACTION is needed and not just words. Thanks to all who continue to be on cutting edge re this topic.

HANG them, they have destroyed the USA and put ALL Amercians at Risk and they must pay. Sorry but we need the DOJ to come and drag them out of wherever they are hiding ONE at a time. They will all give each other up FAST. Then let me throw the 1st BIG rock at them let them see how it feels.

As Mary Jo White interceded for John Mack with Linda Thomsen and got Aguirre fired, we have a similar scenario.

The hedge fund doesn’t have to call the SEC directly. A former employee is seen as a fee generator and lobbyist by the law firm that hires him. The law firm collects fees for lobbying, but they are not registered lobbyists, they are just old friends who know how to play the game.

This fine upstanding guy calls a former collegue and says, “I think you might want to talk to Racer X of X Capital” and baits the guy at the SEC with enough of a teaser to incite a call or gets an invitation for Racer X to call.” The lawfirm generates fees for interceding and Racer X is on his way to knowing that an investigation is underway and initiates a short. There is an intermediary and the short is protected by privilege. The whole thing could be set up through the attorney. The short can be anonymous.

What is the incentive to leave the law firm? Not generating enough fees? Got passed over as partner? No reference in the article to 3 years with a law firm…. Does the hedge fund not like paying all those fees when they could just have an employee do the contact work for less? Why mention the time at the SEC and not mention his most recent employment? Hard feelings? Distrust of attorneys?

What I’ve noticed over the years is an even more despicable behavior by the SEC. When a victimized corporation approaches the SEC asking them to look into the suspicious trading of their shares they would often find themselves to be the target of a “retaliatory investigation” with the cross-hairs now focused on them the victims. I’ve been telling client firms for years whatever you do don’t complain to the SEC. The result of this is the binding and gagging of the victims which dampens the perception of how bad things really are out on the battlefield.

“If you look at the history of enforcement actions at the SEC, the number of actions to deal with pump and dumps vastly, vastly exceeds the number associated with bear raids. Bear raids are very uncommon.”

What a bunch of bunk. They don’t enforce penalties on bear raids, therefore they don’t exist?

The only time that shorts are bad is when they are aimed at wall street companies, as
demonstrated when SEC discontinued short selling to protect their spit swapping friends on wall street. The only thing to do is assign an independent counsel to investigate the SEC and show the public what is really happening. Anything short of an independent counsel is telling the World and American people that you got screwed, shut up and keep your mouth shut. The whole Financial collapse was allowed to happen by refusing to regulate their (SEC) future empolyers.
Treasury Secretary Snow gave all the information that the US Senate needed to stop the destruction of our financial institutions and they didn’t want to hear it. Dodd, Schumer, and Franks should be removed from office for their stupidity.